governance, political economy, institutional development and economic regulation

Netizens- citizens who participate in public debate from the comfort of their broadband enabled “home” space- are a furiously engaged and vocal lot in India. 800,000 of them voiced their support for the nebulous concept of “net neutrality” in an outpouring of outraged emotion, similar to the 2011 Arab Spring which put paid to Hosni Mubarak in Egypt.

Unlike the Arab Spring, this was the revolt of the empowered- internet penetration in India is barely 20%; broadband access is just 8% and 80% of net access is by the privileged owners of smart phones. This boils down to a privileged population of around 9 million netizens in a country of 1230 million citizens.

Like the Arab Spring, the netizen revolt was against a “perceived” threat to their empowerment-in this case cheap access to the internet- which ironically is also one of PM Modi’s promises to the entire Nation.

Keen to dampen the “revolt of the privileged” and anxious to avoid a political fallout, Ravi Shankar Prasad, the Union Telecommunication Minister, hastily set up an expert committee this week to advise him on the subject and publicly re-committed to make the net accessible for all. Sundry netas (politicians) waded in, some equating “net neutrality” with democracy, others raising it to the level of a fundamental right.

The occasion for this frenzy was an exceedingly well articulated and informative Consultation Paper issued by the telecom regulator-TRAI, calling for comments by April 24, on the need, or otherwise, to regulate Over The Top (OTT) services- communication service providers like Facebook or Google; content providers like You Tube or Netflicks; apps providers like Apple or Cloud computing and storage; e-commerce sites like eBay, Amazon and Flipkart. All these provide unregulated, unlicensed voice, audio or text services; they do not need to buy spectrum; they free ride over the “telecom pipes” built by telecom providers and incur none of the obligations (user data privacy, transparency in data management, data security) loaded by the government onto licensed Indian Telecomm providers- Airtel, Vodaphone, Idea, Reliance Comm, TATA Teleservices and Reliance JIO Infocomm.

The cause celebre inciting the wrath of netizens was an impending deal between Airtel-India’s largest and most internationalized mobile services provider and Flipkart-a Singapore-India e-retailer, which went from being a start-up in 2008 to a valuation of US$ 12 billion in end 2014. The deal in question was a “zero-rating” agreement under which customers would get free net access to the Flipkart services with the latter compensating Airtel directly. It is unclear if exclusive hosting of Flipkart on the Airtel network was built into the deal.

Rahul Khullar, the upright and technically brilliant, ex-babu (bureaucrat), economist who chairs the telecom regulator-TRAI, was as astonished as the Minister of telecom by the virulence and strength of the customer reaction. He went public yesterday and blamed the “noise” around the otherwise rather bland, technical concept of “net neutrality (NN)” as an outcome of “a corporate war between a media house and a service provider”.

Here are some facts drawn from the TRAI consultation paper followed by opinions.

Perfect NN is a mirage

First, as the TRAI paper acknowledges, perfect net neutrality (NN) is not practiced anywhere nor is it technically efficient. Management discretion with respect to the manner in which data packets move through the telecom pipes must be left with the service provider so that outcomes (service quality and cost) are optimized.

Inefficient “Free riders” impose costs

Second, just as democracy, by definition, requires the limitation of certain types of individual freedom in the interest of the common good, “free riding” by any player imposes an unfair cost on someone else, which has to be guarded against. This is best done by allowing the market forces of competition and prices to prevail with the government looking closely only at a single bottom line- sustainable benefit for the retail customer.

Innovation, yes but “free riding” no!

Third, for every start up like Flipkart which goes from zero to hero in five years, including by minimizing their upfront cost through “free riding”, there are Dumbo individual users like me who pay Rs 650 every month for a 3GB data plan but end up using only 1 GB. The spectrum space paid for, but left unused by us, is used by the Flipkarts to leverage their business.

Nothing wrong with that. If you are dumb you should lose out. But here is the knockout punch. Costless “free riding” works for all only till there is spare capacity in the “spectrum pipes”. The contention of the telecom providers is that the growth of data intensive OTT products (movies on YouTube and Netflicks; real time Cloud Storage; voice and audio services like Skype and Google Chat) have shrunk the space available in the “pipes” and reduced the quality of service for customers who use conventional voice and data services provided by telecom companies. Ergo new investment is needed to upgrade the “pipes” and more spectrum is needed to accommodate the growth of data intensive 3G and 4G services.

The looming transmission capacity gap

Fourth, demand is exploding. Evolved services like VOIP, video services, digital services-including telemedicine, cloud computing and storage are all data intensive and requires data transmission at high speed (data streaming) with no breaks in between, unlike emails and text, which can take intermittent transmission. Text and standard content can be transmitted using a speed less than 1 Mega Bits per second (MBps). Movies in comparison require speeds of up to 10 MBps. Higher the speed more the requirement of spectrum since there are no “data packet gaps”, which can be packed in with say text, to optimize capacity usage – much like airlines pack spare seats with last minute, flexible time, low priced flyers. TRAI reports that 36% of mobile usage in India is already for movies or video. The global average is 70%. Growth to global levels is limited only by our quality degrading, low transmission capacity.

The government has no time bound, publicly announced plan for releasing spectrum currently hoarded by the army and by the public sector telecom companies-public gifts to them from before spectrum allocation was liberalized and its commercial value became common knowledge.

A spectrum availability gap consequently looms, as TRAI has pointed out to government. This means that TSPs have no option but to extract higher revenue efficiency from the existing spectrum for upgrading infrastructure.

Who should pay for OTT services?

Fifth, it is a standard rule of utility pricing that those on whose account an incremental cost is incurred must be made to pay the higher cost. Prior to the onset of internet based voice, video and instant messaging (chat) the normal share of “voice telephony” in TSP revenues was 70% and the residual 30% was data- sms, emails and other net usage.

Today, globally, the volume of SKYPE (the sms, voice and video over internet firm) traffic is 40% of conventional telephony and its nominal growth is larger than the growth of conventional telephony. Is this the end of the road then for conventional telephone companies? Not quite. In India and similar developing countries, conventional telephony has a reprieve. Until the transmission pipes can be strengthened to deliver good quality OTT services the demand for them will remain constrained. It is not uncommon, even today, for customers to resort to the fixed telephone network when mobile calls have a problem getting connected or get “dropped”.

Clearly, potential customers of OTT services, like movies, cloud computing and music should be ready to pay for the improved net services whilst those who are content with low data intensity conventional services, like text, should be insulated from the price hike. This requires progressive, price discrimination based on data use. Netizens point out that they already subscribe to TSP data plans for high speed access at prices determined by the market.

But TSPs complain that fierce competition constrains them from hiking data access charges for high speed data access. But the generous valuations put by incumbent TSPs in trying to hang onto spectrum allocations in the February 2015 auctions weakens their case of financial stress. The TRAI paper, unfortunately, does not share a marginal cost based assessment of the revenue requirement of TSPs to improve quality and enlarge access.

Willingness to pay

Customers should theoretically be willing to pay a higher price for accessing OTT services but India is a very price sensitive market. Over the last two decades, liberalization, fierce private sector competition and a “Nelson’s eye” regulatory approach to the quality of service, resulted in declining telecom rates and increasing usage. This has fueled a “feel good factor”. No one wants to bust the party.

Whilst conventional TSPs have a vested interest in improving infrastructure quality their business model is under threat from technology and innovation. They have lost business in the lucrative sms market to “free” messaging services like WhatsApp (in the US it charges an annual fee of US$ 1) even though sms charges are nominal at Rs 1 per message. CARE-an Indian rating agency, estimates that the nominal revenues from sms reduced by around Rs 4000 crores (US$ 0.6 billion) in 2013. TSP voice telephony is similarly under attack from voice OTT services. Call charges at Rs 0.5 per minute are the lowest in the world but still uncompetitive with the data cost of a VOIP call of only Rs 4 per minute. This could mean the capacity of TSPs to bear additional “pain” is limited, especially after the generous amounts bid by them in the February 2015 spectrum auctions.

That leaves only the stand-alone communication, content and app providers like Google, Facebook, Amazon – the free riders- who are unwilling to share this cost. However, their Indian clones, like Flipkart may well be willing to submit to licensing and revenue sharing just to grab market share from the entrenched global players-at least in India.

Three options, for taking us out of this conundrum, present themselves:

Back to the future: Minimum data access tariff

First: The nub of the problem is how to extract some of the enormous value being generated in unlicensed OTT services who free ride. TRAI declared regulatory forbearance on telecom tariffs with the onset of competition in services. The results have proved their wisdom. But TSPs complain a combination of artificially created spectrum scarcity have forced spectrum pricing up. Technological innovation has reduced margins on conventional telephony services and revenue flows instead to the OTT providers. The result is shrinking bottom lines for TSPs and cut backs on network upgrades.

One option could be for TRAI to prescribe a minimum tariff for high speed data access, based on the marginal cost of service studies, to ensure sufficient head room for network upgrade and access related investment. This minimum tariff could even be “discovered” by a reverse auction amongst TSPs-along the lines of the coal auctions for user power plants. The alternative is for TRAI do determine the minimum access tariff in the usual manner. This would force user charges for high speed data access up and better compensate TSPs.

The downside is that this option wrecks the ongoing party of the last decade with declining tariff fueling customer well-being. This may not be the best way to ring in Ache Din (PM Modi’s Good Days Are Here assurance)

Bring OTTs into the red tape tangle

Second: The government could license all OTT service providers and divert the additional funds to licensed TSPs to meet their network upgrade costs. This would provide some financial relief to the TSPs and avoid a direct increase in customer telecom tariffs. But the License Fee would have to be significant to make a difference.

The biggest risk is that OTT providers, who by definition are “innovators”, dislike getting caught in red tape. Many of these are global players and shy of entangling with local laws. They could simply walk away. This may not necessarily be a bad thing since in China it resulted in the development of local clones. But India is presently not China. More significantly high License fees will be a bigger barrier for small local “innovators” who lack the deep pockets of foreign OTT providers.

To avoid the considerable barrier of a high upfront License Fee it could be recovered periodically linked to actual network use by an OTT provider. But this arrangement would need to be tracked by DOT or TRAI generating more red tape for OTT to tangle with.

Most important, PM Modi is in the process of defining an “International India”. Reducing transaction cost is an important part of the initiative. Putting OTTs into the muck of red tape does not align with all the assurances of enhancing the ease of “Doing Business”.

OTTs as bulk proxy customers of TSPs

Third, government could work on a dual strategy of massaging both the supply and the demand side of the market. On the supply side, government could announce a time bound plan to release more spectrum to ensure that the scarcity premium on spectrum becomes less burdensome for TSPs.

On the demand side, it could exercise regulatory forbearance from second-guessing the amount of “fat” there is to reallocate between customers, TSPs and OTTs. Instead it could let business arrangements prevail by encouraging mutually beneficial deals between TSPs and OTT providers, whist keeping an eye out to insulate retail customers.

In fact the Airtel- Flipkart deal was a step in this direction. Flipkart proposed to become a proxy, bulk customer for Airtel and pay it directly for the usage of all those who access its services. Small customers of Flipkart would have gained through free access.

To guard against arbitrary blocking or slowing down of access to other OTT providers, who do not choose to have such arrangements or in favour of proprietary OTT products of the TSP themselves, TRAI would need to announce a plan for exercising better oversight over data packet management to limit arbitrary and unreasonable discrimination by TSPs.

This arrangement continues the “party mood” for small consumers. It regularizes an innovative way out of the conundrum, already conceived between Flipkart and Airtel and puts pressure on global OTT players to play ball. India is the fastest growing market for the consumption of OTT products. This provides some leverage to us to lay down reasonable and light handed rules without going to the extreme step of exclusion of foreign OTTs adopted by China. Democracy is indivisible.